Reasonable vs Rational Investing
Being reasonable beats being coldly rational because you'll actually stick with it
Academic finance is devoted to finding the mathematically optimal investment strategy. But in the real world, people do not want the mathematically optimal strategy -- they want the strategy that maximizes how well they sleep at night. A reasonable investor makes decisions in the context of real life: surrounded by co-workers, a spouse, competitors, and personal doubts. The key insight is that if lacking emotions about your strategy increases the odds you'll abandon it when things get difficult, then what looks like rational thinking becomes a liability. The reasonable investor who loves their technically imperfect strategy has an edge, because they're more likely to stick with it for the long run -- and longevity is what matters most when managing money. Just as it may be rational to want a fever when fighting infection, but no patient actually wants one, the mathematically optimal portfolio is useless if you can't tolerate it emotionally.
- Aim to be reasonable rather than coldly rational with financial decisions
- The strategy you can stick with through difficulty beats the mathematically optimal one you'll abandon
- Minimizing future regret is hard to rationalize on paper but easy to justify in real life
- Loving your investments -- even if technically imperfect -- increases the odds of long-term commitment
- Home bias, making forecasts, and other 'irrational' behaviors can be reasonable if they keep you in the game
- Identify where you're optimizing for math instead of behaviorReview your financial strategy and ask: Would I actually stick with this during a severe downturn, job loss, or family crisis? If the answer is no, the strategy is too rational and not reasonable enough for you.Pro tipThe Nobel Prize-winning creator of modern portfolio theory didn't follow his own models -- he split 50/50 to minimize regret. If he can choose reasonable over rational, so can you.WarningDon't confuse reasonable with lazy. Reasonable means deliberately choosing a slightly suboptimal strategy you can sustain, not avoiding financial planning altogether.
- Design your portfolio around emotional toleranceChoose investments and allocation strategies based on what lets you sleep at night, not just what backtesting shows as optimal. Consider your social context -- spouse, family, peers -- because investing has a social component that pure finance ignores.Pro tipIf familiarity with domestic companies helps you take the leap of faith required to stay invested, the home bias is reasonable even if it's not mathematically optimal.
- Test your strategy against your worst-case emotional stateImagine the most stressful financial scenario you can -- market crashes 40%, you lose your job simultaneously, your spouse is anxious. Would you stick with your current plan? If not, adjust until you find the version you would hold through that scenario.Pro tipThe reasonable strategy you maintain for 30 years will almost always outperform the optimal strategy you abandon after 3.WarningDon't wait for a crisis to discover your emotional limits. Stress-test your commitment now while thinking is clear.
- Review and adjust periodicallyRevisit your approach regularly to ensure it still aligns with your circumstances, goals, and emotional tolerance. What was reasonable or appropriate at one stage of life may need updating as your situation evolves.Pro tipSchedule a quarterly review to check whether your financial behavior matches your stated principles.
Harry Markowitz, the Nobel laureate who created modern portfolio theory, invested his own money with a simple 50/50 bond-equity split designed to minimize his future regret -- not to optimize returns according to his own mathematical models.
Fevers are the body's rational defense against infection, shown to slow virus replication by a factor of 200. Yet no patient wants a fever -- they go to the doctor to stop hurting. Medicine universally treats fevers despite evidence of their benefit.
Housel illustrates the concept through the story of Julius Wagner-Jauregg, a psychiatrist who won the Nobel Prize for treating syphilis by deliberately inducing malaria fevers. While fevers are rational responses to infection, no patient actually wants one -- they go to the doctor to stop hurting. Similarly, Harry Markowitz, who won the Nobel Prize for developing modern portfolio theory's mathematical risk-return tradeoffs, invested his own money using a simple 50/50 stock-bond split to minimize future regret rather than following his own optimal models. As Markowitz later explained, he visualized his grief in various scenarios and chose what let him sleep at night.